6 High-Yield Plays in Energy

However, the big payouts come with some serious risks

While the energy sector typically isn’t viewed as a source of yield, there is no shortage of energy-related dividend plays to consider even after the strong gains of the past four months. But not all dividends are created equal. In some cases, investors need to look past the headline dividend number to see if there’s more to the story.

With this in mind, here’s a look at six of the highest-yielding plays in the energy sector.

Vanguard Natural Resources

Click to EnlargeVanguard Natural Resources (NYSE:VNR) is a lesser-known oil and gas driller with an $802 million market cap. While classified by many data providers as an E&P company, VNR is organized as a partnership and therefore will involve a K-1 filing. But it also offers a high (8.7%) — and growing — dividend that places it in the upper reaches of its energy sector peers in terms of yield.

Vanguard is experiencing solid growth and rising earnings estimates, so the dividend is secure. As a kicker, there’s room for capital appreciation: The mean analyst price target is $32.58, which is 20.5% above current levels. A measure of patience is in order, however, as Vanguard has been struggling to break out above a falling 200-day moving average. Put this under-followed name on your radar screen, but wait for the technicals to turn positive before making a move.

San Juan Basin Royalty Trust and Hugoton Royalty Trust

Click to Enlarge San Juan Basin Royalty Trust (NYSE:SJT) and Hugoton Royalty Trust (NYSE:HGT) offer yields in the 7%-8% range based on trailing numbers. The trouble is, both adjust their distributions based on their earnings, which in turn are tied to the price of natural gas. Since natural gas prices have been falling, so too will these royalty trusts’ distributions.

SJT and HGT aren’t without their merits. Even with lower distributions, both will continue to provide superior yields relative to most other areas of the market. Also, they have fallen to extremely depressed levels that largely reflect the expected reduction in their distributions. As a result, there might be meaningful upside in these names if you’re looking for total return — just be aware that the dividend you see listed is not necessarily what you’ll get.

YPF

Click to Enlarge Argentine energy giant YPF (NYSE:YPF) looks like a great investment on the surface, with a favorable growth outlook, impressive shale properties and a yield (10.4%) that exceeds its forward P/E (7.5). However, beneath these numbers lurk hidden political risks. The stock faces the three-pronged threat of government demands that the company increase its domestic production, the possibility that the government also could force the company to slash its dividend, and the potential that its assets could be nationalized (although this appears unlikely).

Absent the political risk, YPF could be a compelling dividend play. As it is, the potential for negative headlines is too high, and the dividend isn’t entirely secure given the activist nature of the Argentine government. Keep an eye on this name for future opportunities down the road, but for now be very wary of the double-digit yield.